A Weird Mo(u)rning re Fiscal Policy

March 26th, 2014 at 11:36 am

I spent a few hours testifying yesterday in what has to be one of the strangest places on earth right now: the US House of Representatives. This isn’t a “pox on all their houses” rap–there are good, earnest, and honest people on both sides trying to figure out how to get out of the terribly damaging morass in which they’re stuck. But the dysfunction seems Sisyphusian.

The hearing, before the Financial Services Committee, was about public debt. Just to set the mood, the Republican chair, Rep. Hensarling, had a debt clock running the whole time on a screen. Here’s my testimony (with a number of cool graphs) and my key points are below, but one thing that was perhaps a tiny bit hopeful was that the witnesses–three R witnesses and yours truly–actually agreed on quite a bit.

We all thought that:

–the only way to achieve a sustainable budget path is not just through spending cuts but through higher revenues as well. The other witnesses were all about “lower rates, broader base,” but I was a bit surprised to hear them all endorse revenue needs, much to the chagrin of their hosts.

–faster growth is essential, and there was some consensus–not complete–that premature fiscal tightening has been damaging to the recovery so far.

–there’s been little evidence so far that the elevated debt/GDP ratio is having a negative effect on anything, though one of the witnesses claimed it was a drag on hiring.

–the path to fiscal sustainability runs through reducing the growth of health care spending, something on which there’s evidence of recent progress, though witnesses disagreed as to whether that progress would persist (no one knows–my view is “maybe/I think so to at least some extent”).

Still, while those are obvious insights, it was odd to see general agreement among the witnesses and so much obvious distance between the members. It gave the whole thing a theatrical, going-through-the-motions flavor. It seemed a far cry from real government where policy makers try to use experts’ insights to guide policy (don’t laugh; I’ve seen that happen) and a lot more like a movie set of “Showdown at Dysfunction Junction.” NOT coming soon, you’ll be glad to hear, to a theater near you.

Summary:

It is common these days for some policy makers to label our debt as “unsustainable.” This is only the case if policy makers fail to undertake further steps to put the debt on a sustainable path, reinforcing the significant improvements in recent years. Those steps must involve a balanced fiscal policy that includes both new revenues and spending cuts, as well as building on recent progress in slowing the rate of growth of health costs.

Increases in the national debt do not automatically signal a fiscal problem and in fact are necessary in special situations. Comparisons of our current fiscal situation to Greece or any other such suggestions of insolvency or excessive fiscal recklessness are ahistorical and misleading. There have been numerous times in our nation’s history — times of war and of large market failures, like the recent “Great Recession” — where temporary expansions of deficits and debt have been essential to meet the challenges we’ve faced.

In fact, austerity measures that seek to reduce deficits and debt too quickly undermine the economy’s ability to recover from the downturn, leading to reduced job and wage growth for the vast majority of working households.

In other words, rising debt is not by itself an obvious fiscal problem. What’s problematic is rising structural debt, meaning debt that increases (or fails to fall) as a share of the economy when a true expansion is solidly underway.

Historically, the last time the debt was falling consistently was in the latter 1990s, when strong growth and more balanced fiscal policy contributed to low deficits, declining debt ratios, and ultimately, budget surpluses. In the 2000s, reckless fiscal policy — particularly large tax cuts — and weak growth reversed these fiscal gains. As I show below, the Bush tax cuts, most of which were made permanent in 2012, are clearly implicated as a major factor driving deficits and debt since they were enacted.

Also in the 2000s expansion, financial excesses and underpriced risk inflated a housing bubble. Its implosion led to deep recession from which we are still recovering. The “Great Recession” required significant fiscal expansion to at least partially offset that demand contraction, yet by dint of their temporary nature, these interventions, unlike the tax cuts just noted, are not at all driving the growth of the longer-term debt.

Since 2010, policy makers have legislated considerable fiscal consolidation and the budget deficit has fallen very quickly in historical terms. In fact, the decline in the deficit as a share of GDP from about 10% in 2009 to 4% in 2013 (fiscal years) is the largest four-year decline since 1950. As noted above, this decline has led to fiscal headwinds that have significantly slowed economic growth and hampered the expansion.

In fact, projected 10-year deficits have decreased by $5 trillion since 2010. A bit more than $4 trillion of those deficit savings have come from legislation including the Budget Control Act, the American Taxpayer Relief Act, and related measures. Importantly, 77% of that $4 trillion in deficit savings has come from spending cuts, meaning only 23% are from higher revenues.

Those facts have at least two important policy implications. First, the oft-cited notion that the current administration has been profligate spenders is demonstrably wrong. In fact, outlays adjusted for inflation and population growth are up 3% relative to 2008, thus including the significant anti-recessionary ramp-up in 2009, and down 12%, 2009-13. Second, future fiscal consolidation must be more balanced, with significant contributions from new revenues.

Going forward, near term fiscal policy must support the still weak recovery. Sequestration cuts and budget proposals to severely cut programs supporting the poor and middle-class as well as key financial regulatory agencies are highly counterproductive. In this regard, the recent budget by the Obama administration offers useful measures to offset harmful discretionary cuts with balanced “payfors.”

In the longer term, it is important to recognize that debt projections are both much improved yet still reveal the need for attention and action. Building on recent progress in slowing the growth of health costs is essential, as are balanced measures that raise new revenues while reducing costs in ways that protect economically vulnerable households. It should also be stressed that the slower growth of health costs is clearly linked to type of cost-saving measures embedded in the Affordable Care Act. To repeal these measures would do deep damage to the long term fiscal outlook.

UPDATE: A colleague just sent me this link which tracks some of the above points nicely…H/t: PvdW.

12 comments in reply to "A Weird Mo(u)rning re Fiscal Policy"

First time commenter, long time reader. Your book with Dean Baker is high on my to-read list.

Regarding your first Summary point, as someone who has been reading a lot on MMT, I would argue that are debt is never “unsustainable” as we are a sovereign nation with a fiat currency. We can never default on our debt obligations as long as we can issue our own currecy and we will never become like Greece.

Also, while I’m very glad that you were able to testify, I’m afraid all your testimony will fall on deaf ears. The current Republican orthodoxy views any growth in government (except defense) as bad and will not consider any solutions outside of spending and tax cuts.

Prometheus stole fire from the Gods and gave it to the people. You want Sisyphus, who was punished by having to spend all day pushing a huge rock up an incline, only to have it roll back down the next day.

Debt is an odd thing, we all know it’s bad in our lives, but few understand that government debt is completely different. And I think most people would be annoyed if they could not buy savings bonds, which they probably don’t equate with debt.

The video link compares the debt to yearly GDP, but a better comparison is to the net worth of the US — that is all the property, resources, etc, in the whole country. I’ve never seen a number but it must be many of orders of magnitude larger than the debt.

17T/188T=0.0904255=9.04%…I wish my personal finances were in this good a position.Greece, Zimbabwe? Just ridiculous to think that a financial actor with an 11:1 asset to debt ratio might be in long term trouble. Some modest inflation, dollar devaluation and fiscal stimulus would likely improve this scenario, but the momentary impact of these policies would yield the most benefit to labor. Debt? What National Debt?